Contract design for wetland restoration policies

The paper discusses how wetland restoration policies could be improved through a more careful design, explicitly taking into account asymmetric information. In particular, the paper applies a principal-agent model to the design of contracts related to wetland restoration measures in Emilia Romagna (Italy). The model searches for the optimal contract design given the social value of wetlands, the opportunity cost of public funds, and the farmers’ compliance costs. We present the results for three different situations: first best, second best with menu of contracts and second best with a flat rate contract. Below a marginal social benefit of wetland of 500 euro/ha, it is not socially worth to restore wetlands. If this value increases, wetland restoration becomes socially profitable. However, high shadow cost of public funds due to the distortionary effect of taxation may still depress the optimal amount of wetlands to be produced. Savings in payments using a menu of contracts may be as high as 15-20% compared to the flat rate payment and social welfare may increase of the same size. The results show that the way in which contracts are implemented in the area can be improved in order to ensure a higher policy efficiency. However they also calls for caution in drawing practical conclusions, and emphasizes that the actual desirability of changes in contract design is strictly connected to the value of environmental services and the shadow cost of public funds, both parameters largely unknown in the area.